‘Massive implications’: One market bear breaks down how the Fed’s unprecedented actions before the coronavirus turmoil may have opened the door to a 72% crash

  • Societe Generale’s Albert Edwards was among several Federal Reserve critics who warned that ultra-loose monetary policy left investors more exposed to a downturn. 
  • A bear market has now arrived at breakneck speed — and Edwards sees a pathway for the stock market to return to its 2009 lows.  
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Critics of the Federal Reserve’s expansion-era policies will be closely watching how the central bank responds to the looming economic recession.

Count Societe Generale’s Albert Edwards among that group.

The bearish strategist long maintained that the Fed’s interventions during periods of market turmoil kept volatility artificially low and allowed companies to fuel their growth through excessive debt

Now that stocks have plunged into a bear market at the fastest pace ever, he is resurfacing this view — not to take credit for foreseeing the coronavirus crisis, but to decode what just happened in markets and what may follow.

In a recent note, he reiterated his view that the Fed’s actions after the financial crisis sustained asset bubbles that made investors more vulnerable in a downturn. The speed of the recent collapse was “in large part” a function of the vulnerability of the system prior to the outbreak, according to Edwards.

“Many of us believe that central bank actions over the last decade have made the current already bad situation much worse than it otherwise would have been,” he said in a recent note.

Moving forward, Edwards envisions the coronavirus crash ushering in the financial “Ice Age” he has predicted for a long time. That term refers to a deflationary spiral similar to Japan’s that sinks the S&P 500 to its 2009 low, turns Treasury yields negative, and creates an economic recession.

Edwards also predicted that the policy response to an Ice Age would be so-called helicopter money from all sides. He sees this already playing out: the federal government is considering sending emergency checks to shore up Americans’ lost incomes.

Meanwhile, the Fed has returned its benchmark rate to zero, relaunched crisis-era lending facilities, and swelled its balance sheet to a new record. 

For Edwards, the rapid sequence of events — a crash that blindsides investors, followed by massive Fed intervention and even bigger fiscal stimulus for damage control — indicate that his Ice Age thesis is playing out. 

“That the policy shift has come much earlier than I had considered likely has massive implications,” Edwards said.

He continued: “Not just in terms of when the Ice Age ends, but whether the equity market collapse will be as deep as we previously expected i.e. testing the March 2009 low of 666 for the S&P. And for the bond market, will US 10y yields still converge with Germany at around minus 1% as we had thought previously?”

A decline in the S&P 500 to the March 2009 low would represent a roughly 72% drop from Friday’s opening level.

The main driver of such a decline would be dried-up company earnings, Edwards said.

With the economy grinding to a halt, multiple public companies are withdrawing their prior earnings guidance. Their losses could be exacerbated by the piles of debt on corporate balance sheets. Corporate debt stood at a record $13.9 trillion at the end of 2019, data from the Organisation for Economic Co-operation and Development showed. 

“If higher US corporate leverage has increased the likelihood of a collapse in profits, even in a mild recession, it beggars the question of what happens now!” Edwards said.

He concluded: “Forward EPS in the current downturn could certainly fall more than the c.40% it crashed in the 2008 crisis. The depth of the downturn could be very deep indeed, despite the aggressive measures being taken.”

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